4/06/2010 @ 12:01AM

Early Warning From Maine, Massachusetts

Last week’s news out of Maine and Massachusetts offers an unappetizing foretaste of the destructive rate battles that will plague the implementation of ObamaCare at the national level. These two progressive states have long championed the extended coverage formulas that figure front and center in ObamaCare. Quite predictably, both states are now feeling the financial crunch. Caught between a rock and a hard place, their insurance commissioners have decided to shoot the messenger by turning down requested rate increases sought by major health care insurers.

These rates were rejected as “excessive” in bad economic times because it was deemed inappropriate to allow these companies to earn any profit. Maine’s insurance commissioner, Mila Kofman, followed the recommendation of Maine Attorney General Janet Mills to limit the large insurer
Anthem
by a premium increase of 10.9%, not the 18.5% that it had requested. The drama played out roughly the same way in Massachusetts, where Gov. Deval Patrick’s insurance commission blocked 235 of the 274 requested increases, thereby forcing insurance carriers to renew coverage at today’s losing rates until the matter is resolved in court.

Many businesspeople in both states expressed a momentary sigh of relief, but their short-term fix is just a prelude of larger problems that will surface again next year. Make no mistake about it, these health care insurers aren’t clamoring for the impossible by insisting monopoly profits in a competitive industry. They are asking only for rate increases that cover their losses from supplying the rich set of mandated benefits for all insureds, including those with pre-existing conditions. This last point is a big deal. In Maine, 1% of customers drive 50% of costs, which are borne by other insureds, the healthiest of whom promptly drop out.

Stripped of rate increases, insurance companies have pushed hard against the health care providers like Harvard’s Partners HealthCare Systems and Pilgrim Health Care to accept lower reimbursement rates. Any intellectual purist is free to side with either insurers or health care operators, so long as they recognize that both will go broke unless new revenue sources are found, which, given current deficits, is just a idle pipedream.

As a matter of first principle, however, this two-state meltdown shows the colossal flaw in the modern theory of health insurance rate regulation. Originally, rate regulation operated as a counterweight to the monopoly power of key providers in network industries–railroads, electricity, power transmission, telecommunications and the like. Those price controls forced these monopoly providers to accept a risk-adjusted competitive return for their services. Knowing, however, that these industries had to invest in infrastructure, courts rejected as confiscatory steep rate cuts that would not allow regulated firms to stay in business.

Here is the catch. Health care insurance is a competitive industry, with no monopoly profits for wise regulators to eliminate. Rate regulation thus makes no sense if its only consequence is to drive up administrative costs while denying competitive firms a competitive rate of return on investment. A sensible constitutional regime would knock out these rate reductions automatically without demanding any detailed case-by-case accounting to reveal the obvious: Open entry eliminates persistent excessive returns. This brass knuckles treatment of state regulators is a pipe dream under today’s permissive constitutional environment that sees rate regulation as an economic panacea. So current regulators first starve the insurance carriers and then invite them do battle with the health care providers.

It is a mug’s game. ObamaCare was meant to end the worries and agonies that come from price uncertainty and health insurance cancellation. That is why Anthem’s ill-timed announcement of its 39% increase in rates in California’s individual markets politically may have been enough to put ObamaCare over the top. So what, the refrain went, that Anthem was losing money in this market? But this political victory over insurer greed is the kiss of death. The federal program has a convoluted structure that allows the states to require price rebates on the recommendation of the federal government. It’s likely that they will invoke that power when rates skyrocket to meet the stiff ObamaCare mandates. So private health insurers and/or health care providers will go bankrupt unless these receive a massive tax bailout, for which there is quite simply no available or potential federal revenue.

There is no mystery here. Maine and Massachusetts have introduced programs that require them to live beyond their means. They give us an early warning system, like canaries exposed to carbon monoxide in the mine. These new entitlement programs can’t breathe without new oxygen. But there is no air in their fiscal oxygen tank. Runaway costs will lead to price controls that will lead to queuing for standard health care services.

Now you have it. ObamaCare, recently sold as a way to control risk, has created a high-risk game that is likely to end in disaster. In the end, even a vaunted public option would prove unable to meet the Obama mandates: The costs will be too darn high. Only competitive markets prized by classical liberals have the long term sustainability that reckless progressives rightly seek. When the oxygen is gone, however, it will prove no comfort to millions of Americans for me to say “I told you so.”

Richard A. Epstein is the James Parker Hall Distinguished Service Professor of Law at the University of Chicago, and the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution. He is also a visiting professor of law at New York University Law School. He writes a weekly column for Forbes.com.